Analysis: Flagging world economy relying on unstable energy boost

Mike Dolan

8 Min Read

LONDON (Reuters) - As storm clouds gather over the global economy again at midyear, lower energy prices are one of the few flickering rays of light on the horizon - even if they too look increasingly ephemeral.

Economic activity and business and household confidence around the globe has tailed off badly again in the second quarter. The headwinds remain fierce, from imponderables related to the latest wave of the euro crisis and European banks’ retrenchment to U.S. fiscal uncertainty and a spluttering of growth engines in the big emerging economies.

Friday’s lukewarm U.S. employment report for June and nagging doubts about the efficacy of latest measures to insulate the ailing euro zone have darkened the skies yet again.

The International Monetary Fund last week flagged an imminent cut to its 3.5 percent 2012 global growth forecast, which is likely to at least reverse its modest 0.2 percentage point April upgrade.

And major central banks in the United States, the euro zone, China and Britain have all eased monetary policy again in recent weeks to ward off the growing chill - positive moves in and of themselves but also a sign of concern about the deteriorating outlook.

One of the few remaining positives over the second quarter — or at least for the majority of countries that import oil — has been an almost $30 per barrel plunge in benchmark crude prices in just three months.

As the global slowdown pulled the demand rug from under the energy markets, the traditional stabilizing effects of oil returned to the fray. So much so that year-on-year drop in oil prices is almost a whopping 20 percent.

“The drop in oil is clearly one of the few hopes, even though everything is contingent on it being sustained and there are so many risks to that. Even then, you have to wonder whether any benefits just get swamped by relentless deleveraging,” said Neil MacKinnon, economist at Russian bank VTB Capital.

WHAT‘S THE HOPE?

Apart from putting more money in the pockets of consumers and firms by lowering fuel bills, and eventually the cost of products with high energy inputs, the drop in oil prices should have a significant impact on consumer inflation rates that are already falling far below the danger rates seen last year.

For central banks keen to ease monetary and financial conditions still further to fill in the hole left by retrenching banks, this amounts to a green light for even further money printing and interest rate cuts.

Monday’s news of a sharp drop in Chinese inflation to a 29-month low of 2.2 percent in June showed just why China’s central bank felt it had the room to cut interest rates last week again for the second time in a month.

But the picture is global. Data from the Organisation for Economic Cooperation and Development shows annual inflation in the 34-country OECD area slowed to 2.1 percent in the year to May 2012 from 2.5 percent in April and was the lowest rate since January 2011 - all heavily influenced by oil and food prices.

JP Morgan economists Joseph Lupton and David Hensley say their measure of global inflation for June is set to move below the aggregated 2.6 percent global central bank target - taken from 26 countries they monitor - for the first time since September 2010 after peaking at 3.9 percent nine months ago.

“If our top-down model is correct, global consumer price inflation could slide to just 2.1 percent by year-end, 0.5 percentage point lower than both our forecast and central bank targets,” the economists said.

What’s more, they added that the slippage is most skewed for the developed economies where consumer prices are more sensitive to moves in oil prices and could both accelerate monetary easing and boost consumer spending there in particular.

“In response to this sharp boost to purchasing power, global consumer spending should accelerate in the second half of 2012. Indeed, based on its historical relationship with oil prices, global consumer goods spending looks set to accelerate to one of the strongest gains in over a decade.”

Other global economy optimists have also picked up on the potential windfalls from oil. Jim O‘Neill, chairman of Goldman Sachs Asset Management, is keen to point out that five-year forward prices of oil — less prone to ebb and flow of short-term spot market moves — have fallen below their 200-day moving averages.

“I’d rather trust the 5-year price than the spot price, and it is now below its own moving average. This has to be good news for anyone, other than those long crude oil,” he told clients in series of slides last month.

What’s more, the broader energy price picture in the United States has for months contained a huge potential fillip as gas prices have fallen sharply relative to the rest of the world due to an unlocking of vast gas reserves in underground shale deposits. If similar deposits were exploited elsewhere in the world, the impact could spread longer-term.

“With little other positive news to grasp onto in recent months, shale gas offers a welcome diversion from the torrent of Eurozone crisis headlines,” said Rob Carnell, chief economist at ING Financial, adding the impact was “significant” for growth inflation and jobs if not as revolutionary as some suggest.

ENERGY TO THE RESCUE?

So, energy to the rescue? Well, maybe.

Long-term futures prices are certainly encouraging for policymakers trying to see through the fog. But the counterbalancing economic effects of spot prices go both ways and worries about oil supplies as much as demand come into play.

No sooner had last month’s EU summit lifted world markets generally, correlated spot oil prices perked back up too.

Fresh nerves about the Iranian nuclear standoff and concern about oil workers’ strikes in Norway pumped crude back briefly above $100 per barrel from lows below $90 last month.

And fears that new money printing from the developed-world central banks has for years now tended to “leak” into commodity markets and prices means the latest wave of monetary easing tends to at least underpin oil prices there too.

IMF economists poring over the question are quick to point out that the world economy has adapted relatively well to the four-fold increase in oil prices in a decade but acknowledge that supply disruptions and a pervasive market fear of long-term scarcity make price spikes higher a constant threat.

In a recent article on the impact of oil prices on world growth, IMF economist Jorg Decressin said growing consumption of oil revenues in oil-exporting countries that used to recycle windfalls back into western debt markets means this buffer for western economies may be weakened -- not least because western interest rates are rock bottom now anyway.

“In the current situation, where global interest rates are low, increased global savings are of little help and oil price spikes would be even more unwelcome. The recycling of oil revenues does not work as well as before,” he wrote.

For now at least, lower energy prices may indeed be a lifeline for a nervous world economy but it’s a lonely positive and far from a stable one.